Preferential allotment of shares is the process by which a company increases its share capital base by issuing further shares to existing or new members. A company may be required to come out with preferential issue for a variety of reasons depending upon the circumstances such as for launching a new project, to meet company’s working capital requirements, to maintain debt-equity ratio or otherwise. In case the company which is desirous of making a preferential allotment of shares is a listed one, then in addition to the compliances required to be complied with under the Companies Act, 2013, the listed company will also be required to comply with the provisions of Chapter VII of SEBI (Issue of Capital & Disclosure Requirements) Regulations, 2009 [“SEBI (ICDR) Regulations”] which deals with preferential allotment. One of the conditions for making the preferential issue stipulated under the SEBI (ICDR) Regulations is that the preferential allotment cannot be made to any person who has sold any equity share of the listed company during the six months preceding the relevant date [Regulation 72 (2)]. The said regulation goes on to explain that where any person belonging to the promoter or promoter group has sold his equity shares in the issuer company during the six months preceding the relevant date, the promoter and promoter group shall be ineligible for allotment of the specified securities on preferential basis. In other words, the law treats the promoters and promoter group as a single unit and therefore, disposal by any one of them would make the other members forming part of the promoters/ promoter group ineligible from participating in the preferential issue. A related question that often comes up while interpreting the said explanation is whether the aforesaid disqualification stipulated under the said regulation 72(2) would be attracted even in cases where there is transfer of equity shares between the promoter group?
By a recent interpretative letter dated September 12, 2016 issued by the Securities & Exchange Board of India (“SEBI”) under the SEBI (Informal Guidance) Scheme, 2003 in the matter of KJMC Financial Services Limited, SEBI has examined these issues and advised that “inter se transfer of shares by way of gift will be considered as “sale” as envisaged in regulation 72(2) of SEBI (ICDR) Regulations, 2009 thereby making the promoters and promoter group ineligible for allotment of specified securities on preferential basis”. One of the observations made by SEBI in the said interpretative letter in order to arrive at the aforesaid conclusion is that “having regard to the provisions of regulation 72(2) of SEBI (ICDR) Regulations, it is felt that the primary intention of the regulation was not with respect to “consideration” but with “change in ownership of equity shares””and therefore, even ‘gift’ would be considered as a ‘sale’ of the purpose of regulation 72(2) of SEBI (ICDR) Regulations. The said interpretative letter has also referred to an earlier informal guidance letter dated February 14, 2012 issued by SEBI on the same subject in the matter of Strides Arcolab Limited wherein SEBI has advised that regulation 72(2) of SEBI (ICDR) Regulations and its explanation do not differentiate between inter-se transfers made to entities within promoter group and sales made to others. Hence, the term “any person who has sold any equity shares of the issuer” shall also include any person who has made inter-se transfers within the promoter group.
The said interpretative letters may be broken down into two parts:
To better understand the first proposition (A), we may refer to the source of the regulations to get a deeper insight into the legislative intent behind stipulating the lock-in requirements. In December, 2003,SEBI had put up on a note on its website for seeking public comments on the recommendations of the Primary Market Advisory Committee (“PMAC”) for certain proposed amendments to Preferential Allotment Guidelines stipulated under SEBI (Disclosure and Investor Protection) Guidelines, 2000 (“DIP Guidelines”). While referring the matter to PMAC for urgent review of Preferential Allotment Guidelines, SEBI provided the following background:
“Of late, some instances of misuse of preferential allotment route by promoters to enrich themselves at the cost of other shareholders, have come to the notice of SEBI. Apparently, promoters are taking advantage of bull run by offloading shares at ruling market prices (which are much higher) and going in for a preferential allotment at minimum price as per the formula given in SEBI (DIP) guidelines (which are lower than current market prices). As such, promoters are profiteering from the bull run and are also in a position to maintain their stake through preferential allotments made to themselves. To address the above concerns, SEBI decided to review the Preferential Allotment Guidelines on an urgent basis to incorporate proper checks.”
On December 1, 2003, the PMAC considered the matter at its meeting and after much deliberations recommended the following amendments to Clause 13.3.1 of the DIP Guidelines:
This was the first time that the concept of pre-issue lock-in and post-issue lock-in conditions for preferential allotment was introduced by SEBI under clauses (a) and (c) above. It may also be noted that the provisions pertaining to preferential allotment as provided under the DIP Guidelines are corresponding to the extant provisions relating to preferential allotment contained under Chapter VII of SEBI (ICDR) Regulations.
In light of the aforementioned background, it would appear that the object of inserting of the pre-issue lock-in and post-issue lock-in conditions by the regulator was to prevent the promoters from offloading their shares during bull run and subsequently acquiring further shares through preferential route at a relatively lower price to maintain their level of shareholding. In other words, the proposed amendments were intended to stop the promoters from making undue profits by selling their shares to third parties at a higher price and subsequently acquiring the company’s shares at a lower price through preferential allotment. The amended regulations,therefore, sought to curb the said mischief by imposing restriction on the transfer of shares by the promoters/ existing shareholders. But the question that needs to be ascertained is as to whether the measures to control such mischief could be further strengthened by restricting transfers inter-se the promoter group, at both pre-issue and post-issue stage?
Regulation 79of SEBI (ICDR) Regulations appears to respond to this question in the negative as far as post-issue lock-in of preferential shares is concerned by providing that subject to the provisions of SEBI (Substantial Acquisition of shares and Takeovers) Regulations, 2011, specified securities held by promoters and locked-in post the preferential issue may be transferred among promoters or promoter group or to a new promoter or persons in control of the issuer; provided that lock-in on such specified securities shall continue for the remaining period with the transferee.
The crucial question, therefore, that emerges is if post-issue transfer of locked-in shares has been expressly permitted by law, should there be a restriction on sale of shares inter-se the promoter group before the preferential issue?If so, what would be the legislative intent behind imposing such restriction?
The aforesaid SEBI’s interpretative letters dated February 14, 2012 and September 12, 2016, fail to adequately address these questions before arriving at the conclusion that pre-issue lock-in condition would apply equally to transfer of shares inter-se the promoter group if done within six months prior to the preferential issue making the them ineligible from participating the preferential issue. In the author’s humble opinion, there appears to be divergence in the views taken by SEBI on the same provision of law at two different point of time (i.e. at the time of introducing legislation and that at the time of interpreting the statutory provisions).
As regards the second proposition (B) put forth in the said interpretative letter to the effect that ‘gift’of shares should be considered as ‘sale’ within the meaning of regulation 72(2),it may be worthwhile to understand the scope of the two terms before dealing with the issue. Transfer of Property Act, 1882 has given the following meaning to the two terms:
‘sale’ is a transfer of ownership in exchange for a price paid or promised or part- paid and part-promised.
‘gift’ is the transfer of certain existing movable or immovable property made voluntarily and without consideration, by one person, called the donor, to another, called the donee, and accepted by or on behalf of the donee.
It is a well settled position of law that sale, gift, exchange, lease, mortgage, lease are all different modes of ‘transfer’each having distinct characteristics and are mutually exclusively of one another.
The said interpretative letter dated September 12, 2016 seems to be a classic case of causus omissus which is to say that where a matter which should have been, but has not been provided for in a statute cannot be supplied by courts, as to do so will be legislation and not construction. When the legislature (i.e. SEBI Board in the instant case) has in its wisdom chosen to use the expression “sale” in the statute, whether it would be prudent on the part of a department of SEBI to extend the scope of the statutory provisions to beyond what the legislature may have originally intended?If it was in fact the intention of SEBI Board to hold the view that gift should also be covered under regulation 72(2) of SEBI (ICDR) Regulations, the correct way to do so ought to have been by making suitable amendments to the SEBI (ICDR) Regulations. The said interpretation may lead to widespread ramifications and opens a plethora of related questions including whether this principle would be further extended to other modes of transfer or to transmission of shares? If so, then how are these restrictions focused at developing the capital market or for that matter, protecting the interest of public shareholders?
The informal guidance given by SEBI acts as guide to the interpretation of the statutory provisions in question. Stock exchanges, depositories and other market intermediaries will normally insist upon compliance of the regulatory provisions in the manner interpreted by SEBI in any informal guidance given and therefore, such interpretation practically becomes the unwritten law.
As per clause 12 of the Informal Guidance Scheme, a no-action letter or an interpretive letter issued by a department of SEBI constitutes the view of the department but the same will not be binding on the Board and hence, the interpretative letters come with the disclaimer that “this letter does not express a decision of the Board on the question referred”. This position is in contrast to the provisions of section 245S(2) of the Income Tax Act, 1961 in terms of which the advance ruling given by the income tax authority is binding unless there is a change in law or facts.
The Informal Guidance Scheme further provides that SEBI shall not be liable for any loss or damage that any person may suffer on account of the Board taking different view from that taken by the department in a letter issued under the Informal Guidance Scheme. This kind of provision appears to be unconducive in the present environment where the regulator is expected to perform its functions by taking full responsibility for all its actions. It is immaterial whether the interpretive letter is issued by a department of SEBI or SEBI Board itself, as any such letter tends to bind all the market participants. The tool of informal guidance is very helpful and deserves to be made more reliable and authentic, for which purpose, SEBI may perhaps consider providing for suitable checks and balances before such informal guidance / interpretative letter is issued.
Ankur Loona is a Principal Associate at Dhaval Vussonji Associates.
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